COOPERS & LYBRAND BACKS SIMPLER RULE FOR ALLOCATING CHARITABLE CONTRIBUTIONS.

Coopers & Lybrand appreciates the opportunity to testify in opposition to the proposed rule concerning allocation of charitable contributions. Our comments are presented on behalf of a broad cross- section of the charitable community, including the 130 charities associated with InterAction, the 90 charities which have associated themselves with the comments of the Fund for Private Assistance in International Development, the Campaign for Oxford, and numerous other charities with operations abroad.

Although we share the view expressed by many others that the proposed regulations are inconsistent with sound tax policy toward charitable giving and, further, are technically and legally flawed, our comments are not directed to those points. Rather, we undertake to provide a framework for analyzing the impact of the proposed rule upon charities with operations abroad, which we conclude is likely to be very substantial. In contrast, we offer support for an alternative rule suggested by the charitable community, i.e., 100% allocation to U.S. income of gifts to domestic charities, which we conclude will eliminate the adverse impact of the proposed rule. Given the severe adverse impact on charities with foreign programs, the interpretation difficulties, and the recordkeeping burdens associated with the proposed rule, we recommend the suggested alternative as a sound exercise of the Treasury's authority to interpret the law in this area.

We do not offer the analysis that follows as definitive, for in some areas the data do not permit precise definition. But we believe we have identified the relevant analytical factors and that they confirm a severe impact upon those charities "disfavored" under the proposed rule.

Several sets of data are necessary to assess impact. First, it is necessary to isolate the donors most likely to be affected by the proposed rule. Second, one must determine the amounts, sources and uses of charitable gifts, and identify the share of these donations attributable to the affected donors. With this analysis, a framework is developed to predict the likely reactions of those donors, and the magnitude of those reactions.

I. WHO IS AFFECTED?

Inasmuch as the required allocation affects only the computation of the foreign tax credit (FTC), those potentially affected are limited to taxpayers claiming the FTC. Both individuals and corporations claim FTC, but in general it is a less significant item for individuals and a far smaller percentage of individuals claim it at all.

In general, either an individual or a corporation is affected by the allocation rules only adversely. That is, allocation of items to foreign source income is never beneficial; it can only operate either neutrally or to limit the allowable FTC. Generally, it will limit the allowable FTC under the excess foreign tax credit rules in those instances in which the U.S. tax associated with foreign source taxable income (after allocation of deductions) is less than the foreign tax paid. Thus, in general, if the overall foreign tax rate is within a range from slightly below to anywhere above the U.S. tax rate, the ability to credit foreign taxes against U.S. tax will be lost at least in part in that year.

Assuming a situation in which the taxpayer is otherwise in perfect equilibrium from a foreign tax credit perspective, allocation of a charitable contribution deduction entirely to foreign source income will result in loss of all tax benefit from that contribution through the mechanism of the foreign tax credit limitation if the overall foreign tax rate equals or exceeds the U.S. rate. ¹

Therefore, those affected by the proposed rules will be a fairly select group of individuals, and multinational corporations doing significant business in industrialized foreign jurisdictions.

It is possible to profile individuals who might find themselves in an excess foreign tax credit posture, but difficult to assess how many there might be and the level of their support of overseas charities. Thus, while we believe the sort of individual who might be in that posture (e.g., a high income individual with substantial business income derived from Germany or the U.K.) is also likely to be a charitable giver, and that the proposed rules therefore are likely to have an impact upon individual giving to charities with foreign operations, we have not undertaken to try to quantify that impact.

Nevertheless, in 1990 individuals made over $100 billion of donations, or 83% of the total. ² Moreover, although a low percentage of individuals claim the FTC, the absolute number is significant. For example, in 1987 some 526,000 individuals claimed FTC of almost 1.1 billion. ³ Therefore, although we cannot quantify impact from individual reaction to the proposed rule, we suspect it would prove to be significant, given the large total of individual contributions, the relative large absolute number of individuals claiming FTC, and the likelihood that the individuals most likely to have excess foreign tax credits are also the most likely to be large contributors. We note, for example, that in 1987 49.7% of the FTC claimed by individuals was claimed on returns with more than $200,000 in AGI.

Although we cannot assess with certainty the impact on contributions from individuals, we can conclude with much greater confidence that donations from the multinational corporate community would be severely affected. The balance of our analysis focuses on these corporations.

While there is inadequate data to exactly assess the incidence of foreign tax credit limitations among multinational corporations, a commonly accepted assumption is that at least half of such corporations are in that category, and some estimates range as high as 75%. This is hardly surprising in view of the 1986 lowering of the U.S. corporate tax rate, and the amount of corporate income now earned in relatively high-tax foreign jurisdictions.

Thus, we have assumed for purposes of further analysis that the donors most likely to be affected are some 50-75% of U.S. multinational corporations.

II. AMOUNTS, SOURCES, AND USES OF CHARITABLE CONTRIBUTIONS -- MULTINATIONAL CORPORATIONS.

According to the 1986 Statistics of Income, corporate charitable contributions totalled about $5.1 billion. But many of those corporate donors are not multinational. We believe a more representative group would be those with $250 million or more in assets. This group gave about $3.5 billion in 1986.

Also in 1986, The Conference Board surveyed 333 companies and determined charitable contributions from those companies of about $1.67 billion. ⁴ Since all of these companies would have been within the presumed multinational SOI class, the Conference Board sample represents about 48% of the total in 1986.

The Conference Board conducted a similar survey in 1989 which showed annual growth in giving by these companies of about 2.8%. From this data, we can project that in 1991 corporate giving by the presumed multinational SOI class would be in the range of about $4.03 billion.

The Conference Board also determined that about 8% of the donations of the corporations it surveyed were to charities operating overseas. ⁵

Therefore, foreign-use giving by multinational corporations in 1991 would be about 322 million (8% of $4.03 billion). ⁶

III. IMPACT UPON CHARITIES

Typically, economic theory predicts that a change in tax treatment applicable to certain actions, such as charitable contributions, will have two opposing effects: One, a "price" effect -- if the tax rate applicable to these deductions were to rise, the net after-tax price the taxpayer faces by making these deductions would decline. Absent any other economic effects, the amount of donations being offered should rise. Second, an "income" effect -- the increase in the tax rate will reduce the amount of income available for donations; without taking into consideration the price effect, this second effect should cause donations to fall. The net result of the tax change is a combination of these two effects, each effecting donations in the opposite direction.

Statistical analyses of corporate giving appear to suggest that the income effect may nearly offset the price effect. In his review of previous research, Clotfelter has found that a 10 percent rise in the tax rate would result in an increase in giving -- a price effect ranging between 4 percent and 10 percent, depending on time period being analyzed and other factors. ⁷ Additionally, he has determined that for a 10 percent reduction in income resulting from the higher tax rate, donations will fall between 10 percent and 11 percent. ⁸

As a consequence, the net outcome of a tax change may generally be relatively small with one important exception: The tax change may induce companies to alter the general TIMING of their donations in order to maximize their advantage from the tax change. Thus, a tax reduction announced in advance is likely to cause corporations to bunch their donations in the year rates remain high and to reduce their contributions by corresponding amounts following the decline in rates.

Evidence in support of this general observation has been outlined by Clotfelter and is also evident in recent information appearing in the Statistics of Income Bulletin. ⁹ Clotfelter tried to disentangle the price effect described above from the influence of timing and discovered that the timing impact was greater and statistically more significant. ¹⁰ Similarly, according to the report appearing in the Bulletin, changes in individual and corporate marginal tax rates under tax reform may have been in part responsible for an increase in contributions to private foundations occurring in 1986 and a corresponding decline in 1987. Total contributions increased by 31 percent between 1985 and 1986, but decreased by 26 percent between 1986 and 1987, suggesting that the change in tax rates may have influenced the timing of deductions.

Unlike the sorts of cases analyzed by Clotfelter, however, the principal impact of the proposed regulations will be to permit some companies currently in an excess foreign tax credit position to reallocate their charitable giving to their U.S. operations and thereby claim a full tax benefit for their donations. Therefore, in contrast to the typical tax change affecting corporate giving described above, the proposed rule will have two effects -- a price effect and an income effect -- which REINFORCE one another.

Under the proposed rules, the net after-tax price for contributions will decline for companies whose donations to U.S. charities currently charged to their overseas income will be assigned to U.S. income. If we simply apply the Clotfelter price elasticity findings to the presumed levels of potentially affected giving, we arrive at a rather significant likely shift in multinational corporate giving for overseas use.

Assuming a price elasticity of (1.0) and a potential change in the tax rate applicable to contributions shifted to U.S. source income of 34%, we can project approximately a 34% reassignment of foreign giving to domestic use. ¹¹ If we assume 50% of multinational corporations are in an excess tax credit posture, and therefore likely to be motivated to take advantage of the proposed rule, then 34% of 50% of $322 million (the total foreign-use multinational corporate giving) will potentially be shifted, or $55 million. If we assume 75% of multinational corporations are in an excess foreign tax credit posture, then the potential shift is 34% of 75% of $322 million, or $82 million.

Further, we are convinced that this analysis substantially understates the likely extent of a shift to U.S. source giving. In all of the instances analyzed by Clotfelter and others, the taxpayer faced a choice of either giving at a different tax rate or not giving at all. The present situation is unique in that the taxpayer may choose to give at EITHER OF TWO tax rates, or not at all. Corporations, unlike individual donors, have fiduciary obligations to shareholders and are subject to various laws and regulations governing their fiscal behavior. A corporation may easily justify continuing to make charitable contributions at a lower tax rate (and therefore a higher cost) where the associated good will may be considered sufficient to offset the reduced tax benefit and where the only other choice is reducing or eliminating contributions. But it is likely to have a far harder time justifying failure to take advantage of a greater tax benefit available for the same contribution. Many contributions will not be able to continue to give at no tax benefit or a reduced tax benefit where a greater tax benefit is readily available. This effect is particularly likely in the case of large contributions, and for the large public companies that characterize the multinational corporate community.

The existing analyses of Coltfelter and others recognize the much greater apparent elasticity associated with timing differences, and we believe the inclination to permanently shift contributions will be greater here, where the tax benefit differential is permanently achievable rather than being available only on a one-time basis.

Thus, it is inferable that the actual shift in contributions to U.S. use resulting from the proposed rule will be far greater than predicted under conventional elasticity analysis. Even if the effect is only twice as great (an assumption well within the likely range of outcomes), the shift away from foreign use charities is in the range of $110 million to $164 million, or as much as half of all multinational corporate funds currently available for these charities' use. Whether expressed in dollars or percentages, the potential impact is staggering and indeed, for some such charities, life-threatening.

To this effect must be added the substantial impact that undoubtedly results from reassignment of individual giving and other corporate giving. Although this shift, as we have stated, is not readily quantifiable, it will nonetheless occur, and it will be substantial and painful.

IV. THE ALTERNATIVE RULE

As numerous others have already said, the proposed rule unnecessarily (and devastatingly as we have demonstrated) discriminates among charities. It also flies in the face of Section 170(c). Moreover, it is exceedingly difficult to interpret and apply in practice, since the place of use of a contribution is not always obvious or easy to determine either factually or technically. It also entails severe recordkeeping and tracking burdens both for charities and donors. Nor does the place of use of a donation logically have any connection to an income stream.

A far simpler alternative is readily supportable under the statute and has none of the flaws of the proposed rule. Neither donors nor donees would object to it. We refer to the option of simply following the guide of Section 170(c) and allocating all contributions made to domestic charities to domestic source income.

Since Treasury is apparently willing to permit essentially ELECTIVE allocation to U.S. income in a context in which foreign allocation is never advantageous, it is difficult to see any objection to the alternate rule.

V. CONCLUSION

We believe the proposed rule will have a profound and demonstrable impact upon charities with operations abroad. The rule is also technically and legally flawed, and creates unacceptable recordkeeping and tracking burdens. The alternate of permitting allocation to U.S. source income of all contributions made to U.S. Charities is fully within Treasury's authority to implement, is sound from both a legal and policy perspective, and creates none of the associated burdens.

Treasury should adopt the suggested alternative.

Peter K. Scott

² Source: "Giving USA: 1990" (New York: AAFRC Trust for Philanthropy).

³ Source: Individual Income Tax Returns, SOI, for 1985-87, tables 1.4 and 5.

⁴ Source: The Conference Board: Report #954 Corporate Contributions, 1989.

⁵ It seems likely that this understates the percentage because it is not always clear at the time of contribution that a donation will ultimately find its way overseas. Thus, although we accept the 8% figure for purposes of analysis, it is likely that the true number is higher and that the impact upon charities with foreign operations is therefore proportionately greater.

⁶ This analysis, focusing as it does on presumed multinational corporations, necessarily ignores any adverse impact of the proposed rule on the other corporate contributions. As with individuals, we cannot quantify impact on those contributions, but total contributions by corporations with under $250 million in assets would be significant, projected to be about $1.84 billion 1991. If 8% of this total is given overseas, then another 147 million is potentially at risk for charities with foreign operations. It is likely that some significant percentage of those contributions would be made by corporations in an excess foreign tax credit posture, and would therefore likely be redirected toward U.S. use under the proposed rule.

⁷ Source: "Corporate Contributions" in Federal Tax Policy and Charitable Giving, Charles Clotfelter, Chapter 5.

⁸ Because a 10 percent tax change is likely to result in a far smaller percentage change in after-tax income, the magnitude of the income-related change in donations is likely to just offset the price-related change.

⁹ See "Private Foundation Returns, 1986 and 1987", Spring 1991 issue.

¹⁰ See "Corporate Contributions".

¹¹ Inasmuch as not all contributions used overseas are allocated entirely to foreign income, the "price" change is probably somewhat less than 34%. However, to the extent contributions made overseas cannot be reallocated, they may not be made at all. Our analysis assumes these factors roughly offset one another.